students who have private information on their ability to learn and can decide to default on debt. We show that the combination … of ex-post moral hazard and adverse selection produces credit market rationing when default penalties are low. When … default penalties increase, the level of student risk aversion proves crucial in determining the market outcome. If risk …

We study a competitive model in which market incompleteness implies that debt-financed firms may default in some states … of nature and default may lead to the sale of the firms’ assets at fire sale prices when markets are illiquid. This … incompleteness is the only friction in the model and the only cost of default. The anticipation of such losses alone may distort …